Rolling returns: a better approach to evaluating investment performance?

When evaluating fund performance, it’s common to look at an investment’s returns over a specific calendar year. However, this method may not reflect the real-life experiences of many investors who typically make decisions throughout the year based on individual goals and the prevailing market environment. Additionally, using calendar year returns may lead an investor to base investment decisions on a single year of strong performance, which might be attributed more to luck rather than a repeatable and consistent investment process.

In our view, analyzing rolling returns may offer a more nuanced view, better reflecting the client experience and providing a more holistic way of evaluating investment performance over time. 

What are rolling returns?

Rolling returns measure how an investment performs over multiple, overlapping time periods. Instead of focusing on a single fixed time frame such as a calendar year, rolling returns evaluate the annualized return over multiple time periods of a specified length, often spanning several years. This approach offers a more comprehensive view of the investment’s overall performance, helping investors to identify performance trends and better understand how an investment might perform over the long term. 

How to analyze rolling returns

Rolling returns are often evaluated relative to an index by comparing the performance of both over several, overlapping time periods. This approach provides a clear picture of how well the investment performs on a relative basis across different market conditions.

By examining rolling returns, investors can gain an understanding of the investment’s consistency, relative strength, and potential for long-term success compared against the benchmark, summed up by the investment’s historical propensity to outperform. This measure refers to the likelihood that the investment will generate a return that exceeds that of the benchmark over a specified period, such as five years.

A high propensity to outperform means that an investment has historically delivered returns above those of the benchmark across various market environments, suggesting a consistent and repeatable investment process. As an example, a fund might outperform the index over 95% of the 199 five-year periods within the reference time frame. While this doesn’t guarantee that an investor holding the investment for five years will outperform the index, it does suggest that the investment has a strong track record and offers a high probability for continued outperformance relative to the benchmark.  

Can rolling returns provide a more informed basis for investment selection?

We believe that rolling returns can offer a better understanding of how a fund might perform over time, primarily due to the ability to consider a larger sample size of data points. When evaluating calendar year returns, investors are limited to a single data point—the interval between the start and end dates of the time period.

In contrast, rolling returns consider multiple time periods, significantly increasing the number of data points. In the scenario outlined above, there are 199 data points used to calculate the five-year historical propensity to outperform. By expanding the sample size, we can have greater confidence that this manager might have the potential to outperform the index over the long term.

This approach also makes it easier to stay the course during market volatility by focusing on an investment’s long-term performance potential rather than short-term market fluctuations. The reality is that periods of short-term underperformance are inevitable, even for the most consistent portfolio management teams. 

Source: Manulife Investment Management, 2024. For illustrative purposes only. This is a representation and not indicative of any fund.

Consider an example where a fund has had a recent period of underperformance relative to the benchmark and peer group. Despite these short-term periods of underperformance, reviewing the average rolling returns reveals that the fund has consistently outperformed both the benchmark and the category average across a range of time periods. This raises an important question: Do calendar year returns paint a picture that truly reflects the best interests of investors? We believe that rolling returns provide a more detailed perspective, helping investors make more informed decisions.

Using rolling returns to identify the value of active management

Beyond providing a perspective on how likely an investment is to outperform an index, rolling returns can also shed light on the historical magnitude, or size, of a fund’s excess return. This metric can help investors understand a fund’s potential to deliver alpha. 

Given that active investment strategies typically come with higher fees, investors need to determine whether these higher costs are justified by the potential for substantial excess returns. By using rolling returns to evaluate a fund’s magnitude of outperformance, investors can make more informed decisions about the effectiveness of a fund’s management team.

While a positive magnitude of outperformance is a good indicator that a fund has been successful in its efforts to outperform the index, it’s important to consider this metric relative to its peers rather than on an absolute basis. The magnitude of outperformance can differ among various investment categories. Some areas of the market, such as fixed income or international equities, may be less efficient than others and provide more opportunities for active management to add value.

Approaching investing through the lens of the client experience

Compared with the traditional practice of looking at calendar year returns, rolling returns highlight the consistency of a fund’s returns and its potential for outperformance relative to both the benchmark and its peers. This approach can provide a more nuanced and comprehensive view of an investment’s performance that’s more closely aligned with investors’ real-life experiences.

By focusing on rolling returns, investors can better assess a portfolio management team’s track record and make more informed decisions around investment selection. This makes rolling returns a powerful tool for evaluating long-term investment success, potentially leading to better investment outcomes.